The S&P 500 has rallied more than 10% off its late December lows, making the reward/risk on the long side a lot less favorable as many of the major indexes and sectors approach overhead supply. When the market is at a point on an absolute basis where the weight of the evidence is mixed, the use of ratio charts to identify the trends that are happening under the surface becomes even more valuable.
Sectors and stocks that held up well during the correction are likely to lead, and that's exactly what we saw from cloud computing, software and other areas of technology that are now leading higher.
However, relative strength is just as important during times when we don't have a directional view on the market. Flat or range-bound performance from an index doesn't mean that there are no trends in place under the surface. This is a market of stocks, so regardless of what the indexes do, there are opportunities on both sides of the tape if you take the time to look.
A great example of this is small-cap consumer discretionary stocks breaking out of a multi-year base relative to the overall market-cap segment. Not only is this another piece of evidence that we can use to mold our overall market view (that's a +1 for risk appetite), but it's also a pairs trade that can be put on and taken advantage of directly.
We look at a massive number of charts every week, including 500 ratios just like these, to help find trends that are informational and/or actionable, regardless of the market environment.
There's a lot of mixed evidence out there right now. Bonds, the yen and precious metals are not giving back much despite the rally in stocks and oil, yet aggressive areas such as small caps, discretionary and technology have led this rally off the lows and continue to act well.
Based on the mixed bag we have today, it's unclear how the major indexes will ultimately resolve themselves. But by consistently identifying the strongest and weakest areas of the market, we can continue to take advantage of the trends that are in place now and know how we can position ourselves one way or another when this period of indecision resolves itself.
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